Two weeks ago the stock market did something notable-- it rallied on extremely bad news. Two Mondays ago the retail figures were reported, they were horrible, and the stock market rallied. Then on Friday of the same week, the unemployment numbers came out, the worst in 35 years, and the market rallied 250 points. This is important, because it certainly looked like the market was "peeking around the corner" and trying to anticipate the state of the economy in mid/late 2009.
For the last 3 months, the stock market has varied between being priced for Depression (value stocks) and a deep Recession (growth stocks). A little perspective is in order here. Just as the peak of the 1999/2000 tech bubble looked like it was "different this time" in an optimistic sense, this trough of 2008 looked like it was "different this time" in a pessimistic sense. The only thing we can point to is that in both instances, the extreme view over time is not likely to be warranted; in other words, when the markets price assets for the extreme case, that is your point of exit or entry to either maximize your selling prices or minimze your buying prices. The truth is that a "normal" market is somewhere between the extremes.
While it doesn't look like we're going to get a Santa Claus rally in the stock market, let us remember that the purpose of all of our getting is understanding. A year like 2008 makes us reflect on those things which are truly important-- our friends, our families, our children, our health. Merry Christmas.
Tuesday, December 23, 2008
Thursday, November 13, 2008
Break Out the Dramamine
Break out the Dramamine, because we're in a market see-saw. October absorbed the full force of the Panic of 2008. The Dow Jones Industrial Average over a 6 day period lost over 20% in market capitalization. However, having said that, the last week of October we experienced a powerful rally, taking the Dow Jones from 8175 to 9625 on Election Day (a 17% rally from the recent bottom). So as of October 31, 2008account valuations will look bad, but recall that just 3 weeks ago it was much worse in terms of market sentiment at the height of the Panic. Fortunately since that already infamous time, the credit "freeze" has thawed considerably, and it "appears" that the market has been creating a range of price support in the Dow 8200 range. This range could drift lower in the next few months (short term), and the market has a great deal of price support in the 7700 range, which we actually visited, albeit briefly, intra-day on October 10.
This will all eventually pass.
By focusing on the long term, and being patient, we will eventually get through this mess, and the markets will eventually recover. For most accounts, where appropriate, recently I raised some cash from assets that I estimate will take longer to recover than U.S.stocks. I will be focusing very selectively and patiently on making purchases in the low 8000 price level on the Dow, during times of pessimism, and raising cash in subsequent Bear market rallies. By doing this, I hope to bring some additive returns to your portfolios on the margins as we look forward over the next (at least) 2 quarters. The next 2 quarters of earnings will be bad, though the trick is realizing that the stock market will eventually look past the short term earnings announcements and begin to look for signs of recovery. This is what the stock market does; it acts as a time machine looking at the future. So eventually, when the gloom and doom looks pervasive, as it did just 3 weeks ago, something will improve.
-ACC
This will all eventually pass.
By focusing on the long term, and being patient, we will eventually get through this mess, and the markets will eventually recover. For most accounts, where appropriate, recently I raised some cash from assets that I estimate will take longer to recover than U.S.stocks. I will be focusing very selectively and patiently on making purchases in the low 8000 price level on the Dow, during times of pessimism, and raising cash in subsequent Bear market rallies. By doing this, I hope to bring some additive returns to your portfolios on the margins as we look forward over the next (at least) 2 quarters. The next 2 quarters of earnings will be bad, though the trick is realizing that the stock market will eventually look past the short term earnings announcements and begin to look for signs of recovery. This is what the stock market does; it acts as a time machine looking at the future. So eventually, when the gloom and doom looks pervasive, as it did just 3 weeks ago, something will improve.
-ACC
Volatility Reigns Supreme
We will get through this volatile market. Today the market had its biggest 1-day rally in 75 years. However, the markets have been in a free-fall over the last 4 weeks, with seemingly no end in sight. With all the fear and uncertainty, we have blood in the streets, and we are approaching the point of what Sir John Templeton would call “maximum pessimism”, which traditionally has been a good time to invest (even when we are not sure where the bottom is). Some high quality institutions are trading at less than the cash value on their books. We are all long term investors, even those investors who have just started, or are about to enter, retirement (since the average retirement lasts 20 years). On Friday markets were at a price level last seen in the 2002/2003 time frame. Since we have been in a very technically driven negative environment, in technical terms we have a lot of “price support” between Dow 7500-8500. This was hardly comforting on Friday, and despite today’s rally, we may touch these levels again as the market attempts to create a “bottom”, and we have all become even longer term investors due to this violent price volatility.
In looking through Client accounts, you own strong companies with strong products and services that were purchased attractively, and many of these companies are quite defensive in nature. Most accounts contain huge doses of high quality health care companies, oil drilling, food, tobacco, alcohol, consumer products/staples, since I typically try to diversify “away from” undue risks in trouble areas. Over the years I have been sometimes questioned for being too conservative in the choice of business enterprises in which to invest, though ACC Clients have at least the comfort that the companies invested in have a bright future, despite the short-term swing in prices. Despite this, the spillover effect from the financial companies is what we are currently swimming in. This weekend’s G7 meeting has resulted in a coordinated global effort to prevent large institutions from failing, and to inject capital directly into banks; this is very positive in the sense that it will help to prevent a situation of fewer and fewer counterparties to absorb “counterparty risk”.
One of the Warren Buffett maxims I try to adhere to is: own quality companies where we can sleep at night even if the stock exchange was closed for 5 years. Had I the foresight of hindsight (i.e. crystal ball), we would of course all be sitting in cash in the beginning of September and starting to buy in here with a 5 year outlook. I still continue to make slight changes in portfolios to take advantage of current prices where possible with a long term perspective, and with new cash am slowly building positions. Companies with solid balance sheets and big dividend payments look attractive, since there are many solid companies with dividends of 4-6% right now, which exceeds the yields on Treasury securities by a lot (granted not as “safe” as a Treasury, but still extremely attractive). With all the “flight to quality”, many investors have flocked to money market and Treasury securities; this trade will eventually reverse as equity yields compete with bond yields. Municipal bonds nationwide have had a tough September and October, but are good relative values at this time, especially relative to Treasury securities on a price and yield basis.
All investors, including myself, have been disappointed with the current economic and market situation, and please know that I am here piloting the ship through these troubled waters. I know you have placed your trust in me, and I will continue to do the best job possible in this environment.
-ACC
In looking through Client accounts, you own strong companies with strong products and services that were purchased attractively, and many of these companies are quite defensive in nature. Most accounts contain huge doses of high quality health care companies, oil drilling, food, tobacco, alcohol, consumer products/staples, since I typically try to diversify “away from” undue risks in trouble areas. Over the years I have been sometimes questioned for being too conservative in the choice of business enterprises in which to invest, though ACC Clients have at least the comfort that the companies invested in have a bright future, despite the short-term swing in prices. Despite this, the spillover effect from the financial companies is what we are currently swimming in. This weekend’s G7 meeting has resulted in a coordinated global effort to prevent large institutions from failing, and to inject capital directly into banks; this is very positive in the sense that it will help to prevent a situation of fewer and fewer counterparties to absorb “counterparty risk”.
One of the Warren Buffett maxims I try to adhere to is: own quality companies where we can sleep at night even if the stock exchange was closed for 5 years. Had I the foresight of hindsight (i.e. crystal ball), we would of course all be sitting in cash in the beginning of September and starting to buy in here with a 5 year outlook. I still continue to make slight changes in portfolios to take advantage of current prices where possible with a long term perspective, and with new cash am slowly building positions. Companies with solid balance sheets and big dividend payments look attractive, since there are many solid companies with dividends of 4-6% right now, which exceeds the yields on Treasury securities by a lot (granted not as “safe” as a Treasury, but still extremely attractive). With all the “flight to quality”, many investors have flocked to money market and Treasury securities; this trade will eventually reverse as equity yields compete with bond yields. Municipal bonds nationwide have had a tough September and October, but are good relative values at this time, especially relative to Treasury securities on a price and yield basis.
All investors, including myself, have been disappointed with the current economic and market situation, and please know that I am here piloting the ship through these troubled waters. I know you have placed your trust in me, and I will continue to do the best job possible in this environment.
-ACC
Tuesday, September 30, 2008
Congress To The Rescue
Oh great, we're all waiting for Congress to "save us" from ourselves in terms of a Bailout Package to deal with bad mortgage paper.
The history of where we are is long and undistinguished. It all started with Jimmy Carter's signing into law the Community Reinvestment Act of 1977, expanding the charter of Fannie Mae and Freddie Mac to increase home ownership. Bill Clinton also got into the act in 1995 and 1998, pushing for further home ownership, as well as the beginnings of the "sub-prime" segment of the market. George W. Bush called for further home ownership for lower income people in 2005. Along the way, efforts to put a lid on Fannie Mae and Freddie Mac were thwarted-- bills to address the oncoming threat posed to the system failed in Congress in 2003 and 2005.
With all of this, we now see the disastrous effects of relaxing the loan underwriting process, including "no doc" loans to people who were under-qualified to make a home purchase. Then we saw the rise of the "zero down payment interest only Adjustable Rate Mortgage", followed by the "negative amortization ARM". These work fine as long as home values are rising, and as long as interest rates do not rise; unfortunately the exact opposite occurred.
The United States is a country built upon credit, and periodically we undergo a financial crisis, a credit bubble, irrational exuberance or whatever other term we want to use. But the reality is that it is *not* irrational to borrow heavily when interest rates are so low; the Fed was basically begging people to borrow. In fact, on a 6% fixed rate mortgage, once you subtract the tax savings on the mortgage, and then subtract the inflation rate, the government is practically paying us to own a home. When home values go up, local tax revenues go up too; when people quit their jobs to flip houses, Federal tax receipts go up. Our long history of pushing the "dream" of home ownership has finally caught up with us, and the message is: there's no free lunch.
And as much as I am opposed to a bailout or rescue package, the alternatives look pretty grim. If the Paulson plan were implemented, Congress would basically take hold of $700 Billion of bad mortgage paper, create a market for it, buy credit-starved institutions some time and liquidity, and eventually (probably) sell the mortgage paper at a later date for a profit. The estimate is that the $700 Billion would buy about $2 Trillion in bad paper (i.e. 30 cents on the dollar). To a market guy like me, this looks like the "trade" of a lifetime, and one that could not only work, but put a huge positive number back into the Treasury at a later date. However, it has to work politically, with checks and balances (not a bad thing). But we're 34 days away from a Presidential election, and therein lies the rub.
The history of where we are is long and undistinguished. It all started with Jimmy Carter's signing into law the Community Reinvestment Act of 1977, expanding the charter of Fannie Mae and Freddie Mac to increase home ownership. Bill Clinton also got into the act in 1995 and 1998, pushing for further home ownership, as well as the beginnings of the "sub-prime" segment of the market. George W. Bush called for further home ownership for lower income people in 2005. Along the way, efforts to put a lid on Fannie Mae and Freddie Mac were thwarted-- bills to address the oncoming threat posed to the system failed in Congress in 2003 and 2005.
With all of this, we now see the disastrous effects of relaxing the loan underwriting process, including "no doc" loans to people who were under-qualified to make a home purchase. Then we saw the rise of the "zero down payment interest only Adjustable Rate Mortgage", followed by the "negative amortization ARM". These work fine as long as home values are rising, and as long as interest rates do not rise; unfortunately the exact opposite occurred.
The United States is a country built upon credit, and periodically we undergo a financial crisis, a credit bubble, irrational exuberance or whatever other term we want to use. But the reality is that it is *not* irrational to borrow heavily when interest rates are so low; the Fed was basically begging people to borrow. In fact, on a 6% fixed rate mortgage, once you subtract the tax savings on the mortgage, and then subtract the inflation rate, the government is practically paying us to own a home. When home values go up, local tax revenues go up too; when people quit their jobs to flip houses, Federal tax receipts go up. Our long history of pushing the "dream" of home ownership has finally caught up with us, and the message is: there's no free lunch.
And as much as I am opposed to a bailout or rescue package, the alternatives look pretty grim. If the Paulson plan were implemented, Congress would basically take hold of $700 Billion of bad mortgage paper, create a market for it, buy credit-starved institutions some time and liquidity, and eventually (probably) sell the mortgage paper at a later date for a profit. The estimate is that the $700 Billion would buy about $2 Trillion in bad paper (i.e. 30 cents on the dollar). To a market guy like me, this looks like the "trade" of a lifetime, and one that could not only work, but put a huge positive number back into the Treasury at a later date. However, it has to work politically, with checks and balances (not a bad thing). But we're 34 days away from a Presidential election, and therein lies the rub.
Thursday, September 11, 2008
Fannie and Freddie In Conservatorship. More Moral Hazard Ahead?
Since July 2007, the financial system has been an absolute mess. This of course has led to liquidity concerns among certain banks, and most recently to the virtual collapse of Fannie Mae and Freddie Mac. This is truly unprecedented. We now have two publicly traded companies (Fannie and Freddie) that were both "implicitly" backed by the U.S. Government, and due to the latest round of liquidity concerns and bad loans, the U.S. Government has made it an "explicitly" backed relationship.
While I decry bailouts and moral hazard, I honestly do not see any other options with this. And the lawyers actually made a smart move too, putting Fannie and Freddie into Conservatorship, rather than Receivership. Why is this important? Well, the distinction is that in receivership, a company continues operations until it completely winds down its commitments (i.e. this would have led to a run on the banks, institutions that trade mortgage backed products would have been destroyed, or in other words, the entire system would have frozen up). By putting these entities into Conservatorship, they continue operations with U.S. Government oversight, the Government backs the paper, liquidity continues, and the market for mortgage backed products continues, though sluggishly.
Famed investor Jim Rogers noted that "the U.S. has become more Communist than China". What he means is that we have virtually created a system where Risk has been Socialized for the benefit of wealthy people, and Rewards are still benefiting wealthy people. I absolutely agree with this assessment, and the risk premium is a big factor in investing. If investors and Wall Street types continue to have their risks socialized via de facto government bailouts, what's to stop them from taking even more undue risks in the future? This is just a reward for moral hazard in the system.
While I decry bailouts and moral hazard, I honestly do not see any other options with this. And the lawyers actually made a smart move too, putting Fannie and Freddie into Conservatorship, rather than Receivership. Why is this important? Well, the distinction is that in receivership, a company continues operations until it completely winds down its commitments (i.e. this would have led to a run on the banks, institutions that trade mortgage backed products would have been destroyed, or in other words, the entire system would have frozen up). By putting these entities into Conservatorship, they continue operations with U.S. Government oversight, the Government backs the paper, liquidity continues, and the market for mortgage backed products continues, though sluggishly.
Famed investor Jim Rogers noted that "the U.S. has become more Communist than China". What he means is that we have virtually created a system where Risk has been Socialized for the benefit of wealthy people, and Rewards are still benefiting wealthy people. I absolutely agree with this assessment, and the risk premium is a big factor in investing. If investors and Wall Street types continue to have their risks socialized via de facto government bailouts, what's to stop them from taking even more undue risks in the future? This is just a reward for moral hazard in the system.
Thursday, August 7, 2008
Lucky 8's?
In China, the number 8 is a sign of luck, which is why they chose 8/8/08 to begin the Olympics in Beijing. It's supposed to be the luckiest day of the century.
Unfortunately, China has been hammered over the last several weeks and months with unlucky things like devastating earthquakes, terrible weather, tsunami warnings, a huge algae probelm in the ocean (caused by excessive pollution and human waste), air quality that resembles another planet, and pollution so bad that China has ordered many factories to be shut down for the last month. They are even shooting special cannisters into the atmosphere to attempt to clear the air. And certain athletes have been denied travel-visas due to their political points of view.
So China, all I can say is..... Good Luck!
Unfortunately, China has been hammered over the last several weeks and months with unlucky things like devastating earthquakes, terrible weather, tsunami warnings, a huge algae probelm in the ocean (caused by excessive pollution and human waste), air quality that resembles another planet, and pollution so bad that China has ordered many factories to be shut down for the last month. They are even shooting special cannisters into the atmosphere to attempt to clear the air. And certain athletes have been denied travel-visas due to their political points of view.
So China, all I can say is..... Good Luck!
Friday, July 11, 2008
Ben Bernanke, Rock Star?
We've heard it all before-- Too Big To Fail. And honestly, some of these institutions, like Freddie Mac and Fannie Mae, are too big to fail. The problem we face is what to do with them... privatize them, bail them out, put them into conservatorship? How do we prevent even more moral hazard in the financials? There are no do-overs here. And the banks are facing their own pressures.
Two weeks ago, Bernanke and the Fed did nothing, and in so doing, they sent a message to the market that was implicitly "we're too worried about the banks and financial system to tackle inflation". So instead of raising rates by .25% and creating a stock market rally based on inflation fighting, and sending an implicit message that the banks will be fine, the market has lost 1000 points in 2 weeks. Had Bernanke and the Fed raised rates slightly, the entire psychological composition of the market would have changed: we'd be fighting inflation, people would invest in the market, financials would be able to raise capital from investors, liquidity would increase... instead, we are where we are.
Nice going Bernanke-- you're a rock star.
Two weeks ago, Bernanke and the Fed did nothing, and in so doing, they sent a message to the market that was implicitly "we're too worried about the banks and financial system to tackle inflation". So instead of raising rates by .25% and creating a stock market rally based on inflation fighting, and sending an implicit message that the banks will be fine, the market has lost 1000 points in 2 weeks. Had Bernanke and the Fed raised rates slightly, the entire psychological composition of the market would have changed: we'd be fighting inflation, people would invest in the market, financials would be able to raise capital from investors, liquidity would increase... instead, we are where we are.
Nice going Bernanke-- you're a rock star.
We're In Bear Territory-- Don't Become Bear Meat
The last 6 months has turned by definition into a Bear Market, where we've seen more than a 20% drop in stock market prices over the last 6 months. I have received a few calls asking if we should sell everything. This is where I earn my keep to prevent making a financially disastrous decision, since wholesale selling here is more than likely 5-10% away from the bottom. The question of selling everything and attempting to time the market is folly, with numerous empirical studies highlighting this type of behavior; when do you sell? when do you get back in? Typically small investors sell at the bottom, wait for the market to recover 10%, then they buy back in; in other words, they miss a 10% pop in prices, then they buy into the top of a bear market rally, then sell again at the bottom of that failed rally. This could happen several times, to the point that what was a 20% loss ends up being a 30% or 40% loss due to making emotional decisions.
This is not the market price level to sell into, this is the market price level to buy into. So investors, particularly retired investors, whose portfolios undoubtedly contain some allocation in bonds, this is where we take some of that bond allocation and buy into stock prices when they're low. That is, sell bonds to someone who desperately wants to buy your bonds from you, and buy stocks from someone who desperately wants to sell them to you. This is the level-headed approach, and also the approach that happens to help even out investment returns over the long run. In this market, let the other guys make the mistakes, and capitalize on their mistakes.
This is not the market price level to sell into, this is the market price level to buy into. So investors, particularly retired investors, whose portfolios undoubtedly contain some allocation in bonds, this is where we take some of that bond allocation and buy into stock prices when they're low. That is, sell bonds to someone who desperately wants to buy your bonds from you, and buy stocks from someone who desperately wants to sell them to you. This is the level-headed approach, and also the approach that happens to help even out investment returns over the long run. In this market, let the other guys make the mistakes, and capitalize on their mistakes.
Thursday, June 26, 2008
What Is The Fed Doing?
Yesterday's decision by the Federal Reserve to "do nothing" has given us a swooning stock market today. Why? Because the Fed's indecision to do the right thing (i.e. raise interest rates) is a signal of lack of will to the financial markets. Not surprisingly, financials held ground yesterday, while industrials dipped, and commodity-related securities rallied in the face of more inflation. Today oil topped $140/barrel due to a weaker dollar, and combining the United States' lack of will to find its own oil reserves, the U.S. market has fallen.
Imagine that the market is a coiled spring that has been wound down to the floor by the heavy weight of negative sentiment, inflation expectation, high oil prices, a weak dollar, a weak economy, and an impending dead-heat Presidential election in which one candidate espouses higher taxes, and the other does not (leading to much market uncertainty). This is all bad, right? Yes, and now it's all baked into the current stock market pricing mechanism. Any improvements on any of these fronts will lead to a higher stock market. In particular, a Fed willing to combat inflation through monetary policy would be welcomed by the market, and we would experience market rallies, even with an added threat to the banking system.
Part of the value of dispensing financial advice is not just about "what to do", but sometimes more often "what not to do". Selling into a weak market is a "no-no". There may be some exceptions to this, but they are rare. Buying into a weak market is a "yes" provided an investor has a long term perspective. So for anyone sitting on the sidelines, it's time to start picking at this market, buying temporarily weak sectors or high-quality out-of-favor companies at low prices.
If you have friends that are paralyzed by this environment, have them give us a call. This type of environment is typically when we receive the most referrals.
Imagine that the market is a coiled spring that has been wound down to the floor by the heavy weight of negative sentiment, inflation expectation, high oil prices, a weak dollar, a weak economy, and an impending dead-heat Presidential election in which one candidate espouses higher taxes, and the other does not (leading to much market uncertainty). This is all bad, right? Yes, and now it's all baked into the current stock market pricing mechanism. Any improvements on any of these fronts will lead to a higher stock market. In particular, a Fed willing to combat inflation through monetary policy would be welcomed by the market, and we would experience market rallies, even with an added threat to the banking system.
Part of the value of dispensing financial advice is not just about "what to do", but sometimes more often "what not to do". Selling into a weak market is a "no-no". There may be some exceptions to this, but they are rare. Buying into a weak market is a "yes" provided an investor has a long term perspective. So for anyone sitting on the sidelines, it's time to start picking at this market, buying temporarily weak sectors or high-quality out-of-favor companies at low prices.
If you have friends that are paralyzed by this environment, have them give us a call. This type of environment is typically when we receive the most referrals.
Wednesday, June 4, 2008
Politics As Unusual
Well, here we are. Barack Obama has just killed the Clinton political machine, and is now the presumptive Democratic nominee. The battle is now on for the political "center" between John McCain and Barack Obama. McCain is "experienced"; Obama is "shiny and new".
I usually attempt not to proselytize about my own views, but rather to give a likely view that could have *big* consequences for the U.S. economy, taxes, investments, U.S. entitlement programs, and foreign policy.
This November of 2008 is a tremendous tipping point for our beloved nation. This election gives us an opportunity to actually solve some tremendous structural problems in our country. So when you're listening to speeches, reading papers, and making your decision, look for honest debate and concern for the following topics...
1) Comprehensive Energy Policy which focuses opening the floodgates of America's economy to solve our energy reliance. 30 year depreciation and huge tax incentives would be a good start here, and the government should *not* choose which technology wins. The market needs to figure it out. A true solution will focus on new supplies of oil AND new technologies. It's not an either/or option.
2) Entitlement Reform for Social Security, Medicare, Government Pension Plans. These plans need to be fixed ASAP, since we're running out of time, our greatest ally. Kicking the can down the road only robs us of time. There are many countries that have solved their similar problems, but we can't do it here? Failure to act threatens to continue to browbeat our currency, affect our Treasury markets, and could erode our standard of living over time.
3) Taxes. Marginal Tax Rates which stay low, or introduce a Flat tax. Dividend and Capital Gains taxes need to remain low. Raising taxes is the death knell for growth, innovation, and morale.
4) Foreign Policy. Like it or not, 2008 is yet another referendum on the Bush Doctrine. People forget that we already experienced one of these in 2004.
I usually attempt not to proselytize about my own views, but rather to give a likely view that could have *big* consequences for the U.S. economy, taxes, investments, U.S. entitlement programs, and foreign policy.
This November of 2008 is a tremendous tipping point for our beloved nation. This election gives us an opportunity to actually solve some tremendous structural problems in our country. So when you're listening to speeches, reading papers, and making your decision, look for honest debate and concern for the following topics...
1) Comprehensive Energy Policy which focuses opening the floodgates of America's economy to solve our energy reliance. 30 year depreciation and huge tax incentives would be a good start here, and the government should *not* choose which technology wins. The market needs to figure it out. A true solution will focus on new supplies of oil AND new technologies. It's not an either/or option.
2) Entitlement Reform for Social Security, Medicare, Government Pension Plans. These plans need to be fixed ASAP, since we're running out of time, our greatest ally. Kicking the can down the road only robs us of time. There are many countries that have solved their similar problems, but we can't do it here? Failure to act threatens to continue to browbeat our currency, affect our Treasury markets, and could erode our standard of living over time.
3) Taxes. Marginal Tax Rates which stay low, or introduce a Flat tax. Dividend and Capital Gains taxes need to remain low. Raising taxes is the death knell for growth, innovation, and morale.
4) Foreign Policy. Like it or not, 2008 is yet another referendum on the Bush Doctrine. People forget that we already experienced one of these in 2004.
Thursday, April 10, 2008
A Crazy Start to '08
What an ugly start to the year. January was bad, just continuing the bloodshed from the end of 2007. February and March weren't much better. However, we experienced two important psychological bottoms in January and in March, which will help the market re-establish and gain its footing.
The first important bottom occurred the Tuesday after MLK, Jr. day, after a weekend in which all other major markets globally had sold off on Monday (when the U.S. market was closed). So here's this psychological agony going on over the weekend, the overnight futures markets showed the market down 600 in overnight trading, and you know what I was doing?: Licking my chops, and I couldn't wait to get into the office to start buying strong companies at give-away prices; after all, this is my job, right? I get paid to be the calm guy and to buy companies when there's blood in the streets.
The thing I hadn't counted on was the Fed, which decided that nobody is allowed to experience any pain anymore. The Fed aggressively lowered rates, lowered the discount rate, and started printing money, injecting liquidity into the banking system at a clip I've never seen before. The market opened down about 550, and within 30 minutes of the Fed's action, about 350 of that juicy fat-pitch down the middle of the plate disappeared back to the upside. I managed to do some buying that day, but not to the extent that I wished to benefit my Clients. Can't an investment manager be allowed (for just 1 day, please Uncle Ben!) to do his job? Frustrating.
The next psychological bottom came on March 7 (Friday), and March 10 (Monday). This of course was the weekend that Bear Stearns went from a market cap of $2.8 Billion on Friday to being sold for $286 Million on Sunday evening to JP Morgan. The firesale was brought about to effectively "bail out" Bear Stearns, with the Fed's help in guaranteeing certain aspects of the deal. It is thought that a failure of Bear Stearns could have unraveled the financial system. Oh, is that all?! Anyway, it was a sweetheart deal for JP Morgan, which saved the financial system that weekend; interestingly, it was J.P. Morgan himself who bailed out the stock exchange about 100 years ago...
With the Fed in a very generous mood to print money, assuage investors, and stem the panic, the market is getting its legs back. There is still a great deal of uncertainty in the market, and pessimism, but this pessimism is temporal; this is the time to be buying quality companies at low valuations. Investors with appropriately long time frames should enjoy nice returns using this strategy, while the speculators are running scared. The longer term negatives that are concerning: inflation is rising, growth is low or stalled, the dollar is weak, and the Fed can only do so much. In fact, we're at the point now where the Fed has little flexibility to do anything should another shoe drop (financial crisis, terrorism, etc.). Congress needs to do its part and *structurally* add incentives for investors to invest by lowering taxes, and control spending, most importantly on our entitlement programs!
The first important bottom occurred the Tuesday after MLK, Jr. day, after a weekend in which all other major markets globally had sold off on Monday (when the U.S. market was closed). So here's this psychological agony going on over the weekend, the overnight futures markets showed the market down 600 in overnight trading, and you know what I was doing?: Licking my chops, and I couldn't wait to get into the office to start buying strong companies at give-away prices; after all, this is my job, right? I get paid to be the calm guy and to buy companies when there's blood in the streets.
The thing I hadn't counted on was the Fed, which decided that nobody is allowed to experience any pain anymore. The Fed aggressively lowered rates, lowered the discount rate, and started printing money, injecting liquidity into the banking system at a clip I've never seen before. The market opened down about 550, and within 30 minutes of the Fed's action, about 350 of that juicy fat-pitch down the middle of the plate disappeared back to the upside. I managed to do some buying that day, but not to the extent that I wished to benefit my Clients. Can't an investment manager be allowed (for just 1 day, please Uncle Ben!) to do his job? Frustrating.
The next psychological bottom came on March 7 (Friday), and March 10 (Monday). This of course was the weekend that Bear Stearns went from a market cap of $2.8 Billion on Friday to being sold for $286 Million on Sunday evening to JP Morgan. The firesale was brought about to effectively "bail out" Bear Stearns, with the Fed's help in guaranteeing certain aspects of the deal. It is thought that a failure of Bear Stearns could have unraveled the financial system. Oh, is that all?! Anyway, it was a sweetheart deal for JP Morgan, which saved the financial system that weekend; interestingly, it was J.P. Morgan himself who bailed out the stock exchange about 100 years ago...
With the Fed in a very generous mood to print money, assuage investors, and stem the panic, the market is getting its legs back. There is still a great deal of uncertainty in the market, and pessimism, but this pessimism is temporal; this is the time to be buying quality companies at low valuations. Investors with appropriately long time frames should enjoy nice returns using this strategy, while the speculators are running scared. The longer term negatives that are concerning: inflation is rising, growth is low or stalled, the dollar is weak, and the Fed can only do so much. In fact, we're at the point now where the Fed has little flexibility to do anything should another shoe drop (financial crisis, terrorism, etc.). Congress needs to do its part and *structurally* add incentives for investors to invest by lowering taxes, and control spending, most importantly on our entitlement programs!
Thursday, March 6, 2008
Mr. Bernanke's Broadside
See below OpEd from today's Wall Street Journal, 3/06/08, which only underscores our blog commentary from yesterday calling Ben Bernanke an "anti-capitalist"...
Bernanke's 'Principal'March 6, 2008; Page A14
We've seen some puzzlers over the years, but we'll admit we never expected to see a Federal Reserve Chairman talking down the capital cushion of the nation's banking system.
But there it was on Tuesday, the equivalent of a CEO shorting his own stock, as Ben Bernanke encouraged the nation's bankers to write down the principal on millions of mortgage loans. Voluntary loan modifications aren't doing enough to stop foreclosures, declared the chief steward of the U.S. financial system. "In this environment," he said, "principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure."
Mull over that one for a moment. Mr. Bernanke and the Fed are charged with protecting the soundness of the banking system. The bulwark of such protection is shareholder equity -- capital -- which is generated in part by income-producing assets known as loans. Yet the Fed chief has now advised that, as a matter of public policy, banks should take a chunk of that capital and transfer it to mortgage debtors. How this additional charge -- and new political risk -- against bank earnings will ease the mistrust at the heart of the current credit crisis is a mystery.
This came only a few days after Mr. Bernanke had publicly advised Congress that more banks will fail. And it came on the same day that the Fed's Vice Chairman, Donald Kohn, told Capitol Hill that bank earnings are under increasing pressure. Amid such earnings strain and uncertainty about how far real-estate prices will fall, now seems an especially bad time for a Fed chief to instruct banks to create further losses.
It's not as if bankers don't understand their mortgage predicament, or have no sympathy for borrowers. But how, and whether, to renegotiate their loan contracts is a matter for them to decide. They might choose to lower the interest rate on some mortgages, reduce the principal amount on others, or foreclose and repossess homes on the hopeless cases. If the Fed, in its regulatory role, thinks a bank should be more aggressive in taking asset write-downs, it can order that on a bank by bank basis. Elevating principal write-downs to a general banking principle is regulatory overreach.
Only the day before Mr. Bernanke dropped his bomb, Treasury Secretary Hank Paulson disclosed that "since July more than one million struggling homeowners received a workout -- either a loan modification or a repayment plan that helped them avoid foreclosure." In January alone, there were 167,000 such modifications, with the number of borrowers receiving help rising faster than the number of foreclosures.
Mr. Bernanke's broadside might well hamper these voluntary workouts by signaling to other borrowers that they needn't do anything at all. They can merely sit tight and wait for their banker to tell them they don't owe nearly as much as they thought. Or they'll conclude they can wait for Congress to provide its own mortgage bailout, this time on the backs of taxpayers who decided not to speculate on real estate during the housing bubble, or not to purchase a more expensive home than they could afford.
It's no coincidence that one of the chief advocates of a government mortgage bailout, House Financial Services Chairman Barney Frank, hailed Mr. Bernanke's remarks as an endorsement. Meanwhile, Mr. Paulson had to wonder why Mr. Bernanke was undermining the Treasury Secretary's sensible public opposition, expressed on Monday, to a taxpayer rescue. Do the gentlemen not like each other?
The worst irony here is that the mortgage crisis is in large part the fault of the Fed's own reckless monetary policy. Low real interest rates for too long created a subsidy for debt that spurred the housing and credit bubbles that have now burst. Prices got higher than they should have been, and the first step in any recovery is letting those now-falling prices find a new bottom. Government interference in that price discovery will only prolong the crisis, increasing the chances that the losses are eventually dumped onto taxpayers.
The government is already well down this road with its expansion of the Federal Housing Administration's authority, and its unleashing of an unreformed Fannie Mae and Freddie Mac. Given his ostensible independence, the Fed Chairman is supposed to be a crucial restraint on all of this moral hazard and political panic. If the Fed can't do that, we might as well let Congress run the banking system.
Bernanke's 'Principal'March 6, 2008; Page A14
We've seen some puzzlers over the years, but we'll admit we never expected to see a Federal Reserve Chairman talking down the capital cushion of the nation's banking system.
But there it was on Tuesday, the equivalent of a CEO shorting his own stock, as Ben Bernanke encouraged the nation's bankers to write down the principal on millions of mortgage loans. Voluntary loan modifications aren't doing enough to stop foreclosures, declared the chief steward of the U.S. financial system. "In this environment," he said, "principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure."
Mull over that one for a moment. Mr. Bernanke and the Fed are charged with protecting the soundness of the banking system. The bulwark of such protection is shareholder equity -- capital -- which is generated in part by income-producing assets known as loans. Yet the Fed chief has now advised that, as a matter of public policy, banks should take a chunk of that capital and transfer it to mortgage debtors. How this additional charge -- and new political risk -- against bank earnings will ease the mistrust at the heart of the current credit crisis is a mystery.
This came only a few days after Mr. Bernanke had publicly advised Congress that more banks will fail. And it came on the same day that the Fed's Vice Chairman, Donald Kohn, told Capitol Hill that bank earnings are under increasing pressure. Amid such earnings strain and uncertainty about how far real-estate prices will fall, now seems an especially bad time for a Fed chief to instruct banks to create further losses.
It's not as if bankers don't understand their mortgage predicament, or have no sympathy for borrowers. But how, and whether, to renegotiate their loan contracts is a matter for them to decide. They might choose to lower the interest rate on some mortgages, reduce the principal amount on others, or foreclose and repossess homes on the hopeless cases. If the Fed, in its regulatory role, thinks a bank should be more aggressive in taking asset write-downs, it can order that on a bank by bank basis. Elevating principal write-downs to a general banking principle is regulatory overreach.
Only the day before Mr. Bernanke dropped his bomb, Treasury Secretary Hank Paulson disclosed that "since July more than one million struggling homeowners received a workout -- either a loan modification or a repayment plan that helped them avoid foreclosure." In January alone, there were 167,000 such modifications, with the number of borrowers receiving help rising faster than the number of foreclosures.
Mr. Bernanke's broadside might well hamper these voluntary workouts by signaling to other borrowers that they needn't do anything at all. They can merely sit tight and wait for their banker to tell them they don't owe nearly as much as they thought. Or they'll conclude they can wait for Congress to provide its own mortgage bailout, this time on the backs of taxpayers who decided not to speculate on real estate during the housing bubble, or not to purchase a more expensive home than they could afford.
It's no coincidence that one of the chief advocates of a government mortgage bailout, House Financial Services Chairman Barney Frank, hailed Mr. Bernanke's remarks as an endorsement. Meanwhile, Mr. Paulson had to wonder why Mr. Bernanke was undermining the Treasury Secretary's sensible public opposition, expressed on Monday, to a taxpayer rescue. Do the gentlemen not like each other?
The worst irony here is that the mortgage crisis is in large part the fault of the Fed's own reckless monetary policy. Low real interest rates for too long created a subsidy for debt that spurred the housing and credit bubbles that have now burst. Prices got higher than they should have been, and the first step in any recovery is letting those now-falling prices find a new bottom. Government interference in that price discovery will only prolong the crisis, increasing the chances that the losses are eventually dumped onto taxpayers.
The government is already well down this road with its expansion of the Federal Housing Administration's authority, and its unleashing of an unreformed Fannie Mae and Freddie Mac. Given his ostensible independence, the Fed Chairman is supposed to be a crucial restraint on all of this moral hazard and political panic. If the Fed can't do that, we might as well let Congress run the banking system.
Tuesday, March 4, 2008
Anti-Capitalist Running The Federal Reserve?
In case you missed it, Ben Bernanke, current Chairman of the United Socialist Soviet Republic Federal Reserve, has recommended that "government and private entities cooperate" in reducing some of the stresses on homeowners whose home equity may have dropped in the mortgage meltdown.
http://www.bloomberg.com/apps/news?pid=20601103&sid=aLPiHQ.ASN48&refer=us
Specifically, Bernanke is asking banks to "forgive" some portion of the mortgages held by the banks so that consumers might have some home equity left, presumably to prevent their walking away from their homes (which would prevent even more foreclosures). However, the most likely effect would be (presuming that these same homeowners arent' great at math) that they would simply tap their remaining lines of credit and buy more TV's, home appliances, and pay off credit card debt.
Let's play the logic game. Who is "government"? Eventually that will end up being you and me, and we will pay to subsidize other people's foolishness. Who are "private entities"? These are the banks who participated in creating mortgage contracts with people to purchase their homes. If the banks were to take Bernanke's idea to heart, credit will freeze up even further, which further exacerbates the crisis! So let's get this straight: consumers who financed high priced homes with adjustable rate mortgages, or negative amortization mortgages, and fudged their documentation using "no doc" loan papers (where they pay a higher rate without income verification, but then take the teaser ARM or Negative Amortization rates), need to be bailed out collectively by those "mean sinister banks" and by those "kind generous smart U.S. citizens" who try to spend less than they earn? No. Way. The quickest and most efficient way out of this mess is to let the market actually "work", which means prices need to fall enough for buyers to buy homes again (note to Bernanke: in economics this is called pricing equilibrium).
As far as I'm concerned, Bernanke is a collectivist anti-capitalist. This idea reeks of desperation, of Fed muddling, of having no policy flexibility, and attacks the banking system even further. This is anti-capitalist, and applies Socialist/collectivist solution sets to problems. These solution sets only give more incentive for consumers in the future to make bad choices, and should be avoided at all costs. But instead of just ripping the band-aid off the wound, Bernanke likes to slowly pull it off, taking off one hair and one skin cell at a time.
http://www.bloomberg.com/apps/news?pid=20601103&sid=aLPiHQ.ASN48&refer=us
Specifically, Bernanke is asking banks to "forgive" some portion of the mortgages held by the banks so that consumers might have some home equity left, presumably to prevent their walking away from their homes (which would prevent even more foreclosures). However, the most likely effect would be (presuming that these same homeowners arent' great at math) that they would simply tap their remaining lines of credit and buy more TV's, home appliances, and pay off credit card debt.
Let's play the logic game. Who is "government"? Eventually that will end up being you and me, and we will pay to subsidize other people's foolishness. Who are "private entities"? These are the banks who participated in creating mortgage contracts with people to purchase their homes. If the banks were to take Bernanke's idea to heart, credit will freeze up even further, which further exacerbates the crisis! So let's get this straight: consumers who financed high priced homes with adjustable rate mortgages, or negative amortization mortgages, and fudged their documentation using "no doc" loan papers (where they pay a higher rate without income verification, but then take the teaser ARM or Negative Amortization rates), need to be bailed out collectively by those "mean sinister banks" and by those "kind generous smart U.S. citizens" who try to spend less than they earn? No. Way. The quickest and most efficient way out of this mess is to let the market actually "work", which means prices need to fall enough for buyers to buy homes again (note to Bernanke: in economics this is called pricing equilibrium).
As far as I'm concerned, Bernanke is a collectivist anti-capitalist. This idea reeks of desperation, of Fed muddling, of having no policy flexibility, and attacks the banking system even further. This is anti-capitalist, and applies Socialist/collectivist solution sets to problems. These solution sets only give more incentive for consumers in the future to make bad choices, and should be avoided at all costs. But instead of just ripping the band-aid off the wound, Bernanke likes to slowly pull it off, taking off one hair and one skin cell at a time.
Tuesday, February 12, 2008
Investing in Uncertain Times
Amid the subprime mortgage fallout, the U.S. housing market has seen a marked drop in demand, higher levels of unsold inventory, and an increase in foreclosures. Media coverage of these events seems to emphasize that the fallout is unclear, that conditions may worsen, and that the total impact will not be known for some time.
These are precisely the conditions to engage in contrarian investing. At this point of the investment cycle, the valuations of select companies are very attractive, meaning that their current market valuations are trading below their intrinsic values. Examples abound in the financial sector, pharmaceutical sector, auto sector, and food sector. It's understandable for Clients to wonder whether purchases in these areas are "too early", given the potential for continued deterioration, especially in currently unpopular sectors of the economy. How can we determine fair values for companies when the total impact of such current events may be still unknown?
In difficult times stock prices tend to exaggerate the prevailing uncertainties. Opportunities are created where individual stock prices fall below a rational assessment of business worth. Keep in mind that an assessment of business value is conservative and not precise; intrinsic value estimates are dynamic. Often it is best to describe intrinsic value estimates as a "neighborhood", not as specific address. Reversion to the mean allows us to take advantage of short-term price declines that can create long-term opportunities. When the relative difference between stock price and assessed fair value is great enough, the investment decision is not dependent on precision.
These are precisely the conditions to engage in contrarian investing. At this point of the investment cycle, the valuations of select companies are very attractive, meaning that their current market valuations are trading below their intrinsic values. Examples abound in the financial sector, pharmaceutical sector, auto sector, and food sector. It's understandable for Clients to wonder whether purchases in these areas are "too early", given the potential for continued deterioration, especially in currently unpopular sectors of the economy. How can we determine fair values for companies when the total impact of such current events may be still unknown?
In difficult times stock prices tend to exaggerate the prevailing uncertainties. Opportunities are created where individual stock prices fall below a rational assessment of business worth. Keep in mind that an assessment of business value is conservative and not precise; intrinsic value estimates are dynamic. Often it is best to describe intrinsic value estimates as a "neighborhood", not as specific address. Reversion to the mean allows us to take advantage of short-term price declines that can create long-term opportunities. When the relative difference between stock price and assessed fair value is great enough, the investment decision is not dependent on precision.
Tuesday, January 22, 2008
January Was Named for Janus
Janus, a God during Roman times, had two faces looking in two different directions, and boy has he been playing rough this month! Unfortunately the direction of the markets in January has been the down, down, down direction. Again we've seen earnings weak in the financial sector, with more and bigger writedowns from the credit crisis.
The credit crisis that we've seen unfold in the last several months has occurred due to lack of faith in how assets were priced in the mortgage market, collateralized debt obligation market, the collateralized mortgage obligation market, etc. Basically, because the "faith" aspect vanished, the market for these securities vanished with it, and with no one on the buy side of the equation, the banks and investment banks have been forced to "write down" the value of these securities, and *still* the valuations of these securities is questionable.
Our best guess as to what will happen is that there needs to be capitulation by CEO's! Yes, the CEO's, who are embarrassed and fighting for their jobs with the Boards of their companies, will need to *aggressively* write down assets each quarter as they "mark to market" the values of these securities. What will eventually happen is that the writedowns will be so big as to be actually conservative on the down side; in which case all the bad news will be out, the credit market will price this information in, valuations will improve, and then all of a sudden the banks will *re-state* a prioir quarter TO THE UPSIDE. When this happens 2 or 3 times with the banks, that will signal the bottom in the financials.
The credit crisis that we've seen unfold in the last several months has occurred due to lack of faith in how assets were priced in the mortgage market, collateralized debt obligation market, the collateralized mortgage obligation market, etc. Basically, because the "faith" aspect vanished, the market for these securities vanished with it, and with no one on the buy side of the equation, the banks and investment banks have been forced to "write down" the value of these securities, and *still* the valuations of these securities is questionable.
Our best guess as to what will happen is that there needs to be capitulation by CEO's! Yes, the CEO's, who are embarrassed and fighting for their jobs with the Boards of their companies, will need to *aggressively* write down assets each quarter as they "mark to market" the values of these securities. What will eventually happen is that the writedowns will be so big as to be actually conservative on the down side; in which case all the bad news will be out, the credit market will price this information in, valuations will improve, and then all of a sudden the banks will *re-state* a prioir quarter TO THE UPSIDE. When this happens 2 or 3 times with the banks, that will signal the bottom in the financials.
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